Before releasing the latest ratings, Fitch had initially warned about a possible downgrade during US debt ceiling negotiations a few months ago.
Fitch Ratings, one of the major credit rating agencies, downgraded the United States’ long-term foreign currency issuer default rating to AA+ from AAA on August 1. The move comes amid concerns over expected fiscal deterioration over the next three years and the erosion of governance standards, raising a growing general debt burden.
The agency also pointed out that the repeated political standoffs and last-minute resolutions over the debt limit have damaged confidence in fiscal management. Fitch had previously placed the nation’s AAA rating on negative watch in May, attributing it to the debt ceiling fight and the uncertainties surrounding the federal government’s funding. However, lawmakers in Washington eventually reached an agreement, preventing the government from running out of money.
US Government Standards Declines
The agency further stated that governance standards have steadily declined over the past two decades, despite a bipartisan agreement to suspend the debt limit until January 2025. Fitch also expressed concerns regarding the lack of a medium-term fiscal framework and a complex budgeting process, contributing to successive debt increases over the past ten years.
“In Fitch’s view, there has been a steady deterioration in governance standards over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025,” Fitch said.
Additionally, the rating agency highlighted the rising general government deficit, which is expected to reach 6.3% of GDP in 2023, up from 3.7% in 2022. Fitch stated that the recent cuts to non-defense discretionary spending agreed upon in the Fiscal Responsibility Act would only offer a modest improvement to the medium-term fiscal outlook.
The rating agency projected the possibility of the economy slipping into a mild recession in the fourth quarter of 2023 and the first quarter of 2024 owing to tightening credit conditions, weakening business investment, and a slowdown in consumption.
US Treasury Secretary Disagrees with Fitch’s Ratings
US Treasury Secretary Janet Yellen voiced her disagreement in response to the downgrade, calling the decision “arbitrary and based on outdated data.”
Like Yellen, the White House also disagreed with Fitch’s ratings.
“It defies reality to downgrade the United States at a time when President Biden has delivered the strongest recovery of any major economy in the world,” said Karine Jean-Pierre, the White House press secretary.
The government emphasized its ongoing efforts to deliver a robust economic recovery, citing the country’s exceptional strengths, including a large, well-diversified, high-income economy.
While the ratings downgrade surprised investors, analysts believe the impact on financial markets may be limited, as government guarantees are deemed more crucial than credit ratings in many contracts. Nonetheless, some economists questioned the timing of the downgrade, given the current strength of the US economy and progress in tackling inflation.
Fitch Warned about the Downgrade in May
Meanwhile, before releasing the latest ratings, Fitch had initially warned about a possible downgrade during US debt ceiling negotiations a few months ago. Even after the crisis was resolved in June, the agency maintained its stance on completing the review in the third quarter of this year.
The announcement caused the dollar to drop against various currencies, while stock futures slightly declined and Treasury futures rose. Despite these reactions, numerous investors and analysts predict that the impact of the downgrade will likely remain limited.
Surprisingly, the downgrade occurred despite the US debt ceiling crisis resolution two months prior. In May, an agreement was reached between President Joe Biden and the Republican-controlled House of Representatives, putting an end to months of political brinkmanship and raising the government’s borrowing limit to $31.4 trillion.